This is the eighth article in a series about Post Modern Security Analysis.

Truth, Fact, and Opinion

Fundamental concepts in open source research include “truth”, “fact”, and “opinion”. These ideas have occupied philosophers since the beginning of history.

Since Post Modern Security Analysis is meant to be a practical field, it is convenient to choose a rather arbitrary, but useful, definition for these terms:

1. Truth: Objective reality in a theoretical universe that lies beyond human capacity of verification. Philosophers have many definitions of truth, but for practical purposes, we shall think of truth as a ideal — a goal that never can be obtained with certainty.
2. Facts: Statements that would generally be accepted, universally, as representing truth, based on available knowledge at a particular time. At one time, that the earth was the center of the universe was considered to be true. Later, people thought it true that the sun was the center of the universe. Still later, the idea that the universe had a center at all was in doubt. Today, scientists ponder “parallel universes” and “membranes“.   “A fact is a pragmatic truth, a statement that can, at least in theory [to a certain degree], be checked and confirmed. … A scientific fact is an objective and verifiable observation, in contrast to a hypothesis or theory.^[1]“
3. Opinion: Any statement that would generally be regarded as a belief or non-factual interpretation or position of a particular individual or group. An opinion may be based on fact, on conjecture, or on faith — but is still only an opinion. Theories and hypothesis are opinions, not facts. All belief systems have at the core a set of axioms or fundamental propositions that cannot be proven and must be taken on faith. That millions of people, or even a majority, may hold a certain opinion, does not make that opinion a fact, unless the opinions would almost universally be regarded as true.

Most open source information about capital markets is opinion. Prices in securities markets are expressions of opinion (among other things such as the forces of supply and demand). What passes for a “research report” in most investment markets is almost always a statement of opinion, which may or may not be based on fact.

Relevant facts

The central idea of Post Modern Security Analysis is to rigorously separate the gathering of relevant facts from the development of useful opinions based on the analysis and interpretation of these facts.

“Relevant facts” are those that help answer questions that the analyst poses at the start of the research process. Every research assignment should start out with express or “implied” questions that guide the researcher in sorting useful from irrelevant information.

See: Implied questions on Capital Market Wiki and Recommended formats for research projects.

Most information available on the Internet regarding capital market topics — both, opinion and fact — is irrelevant to the purpose of most research projects. For example, a research project on the Ford Motor Company will turn up thousands (or millions) of pages about the various automotive models produced by the company, information on car repair, tips on bargaining with car dealers, and so forth.

The fact that the New York Stock Exchange sponsored the racing car driver Marco Andretti is interesting, but irrelevant, to most capital market research projects about that exchange.

See: Open source analysis tradecraft.

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The US SEC is not geared, in any practical sense, to protect investors against fraudsters in the mold of Bernard Madoff.

They will not admit this, and this is a shame, because the public, believing that the SEC is there to protect them, fails to take reasonable precautions themselves.

The SEC would do investors a great service simply by requiring all those in the investment business to post on their office wall or website a notice saying,

“The SEC will not protect you against this firm. The firm and its employees may be fraudsters and steal your money. You’re on your own!”

Why fraud prevention is not in the SEC genetic makeup

I   spent the decade of the 1990s, advising the Indonesian government on securities regulatory practices. During this time, I worked side-by-side with my good friend, the late John Evans, who had been a US SEC commissioner for ten years. Our consulting group, from time-to-time, included experts who had been SEC staffers. A large part of the job consisted of researching SEC administrative cases.

One case, in particular, stuck in my mind:

At one time, the SEC successfully brought charges against an investment advisor for fraud, sending the individual to jail. Having served his time, the convicted fraudster applied to the SEC for a new license as an investment advisor. The SEC turned him down, on the reasonable grounds that he had already served time for defrauding investors in this very calling. However, the fraudster appealed to the court and won. The SEC was forced to grant this individual a license. The court said that just because someone engaged in defrauding investors in the past, he had already paid his debt to society (although perhaps not to the defrauded investors), and the SEC should not deprive a person of his right to earn a living.

This case illustrates the problem that the SEC faces in preventing fraud. It must follow the law, not commonsense.

The SEC can issue rules and as long as an individual follows these rules, the SEC will not act on mere suspicion. SEC staffers do not advance their careers by using resources to investigate possible fraudulent operations. Like the police, they need a body first.

The rule is: “Wait until there is a victim. Then investigate.”

Commissioner Mary Shapiro’s lost opportunity

If the SEC was at all serious about cracking down on securities fraud, the first thing Chairman Shapiro should have done would have been to fire all those even remotely involved in dropping the ball in the Madoff case. This firing should have been public, with great headlines.

The “perps” should have been publicly shamed.

The Madoff victims should at least have been comforted by the knowledge that careless SEC staffers lost not only their jobs, but also their pensions and their Obama-proof, gold-plated, government health plans. Instead, the SEC drew up its wagons and protected its own. Screw the investors!

If the SEC had taken action against its own people, staffers would be a lot more careful and would take seriously reports from whistle-blowers.

As it is, there is absolutely no penalty imposed upon a SEC official for failing to protect investors by investigating suspicious behavior.

Rather, the opposite is true. Remember, Bernard Madoff was a big shot, with connections. SEC commissioners get phone calls from members of Congress.

Congress can wreck careers, defrauded investors can’t.

Inefficient law enforcement

Law enforcement in the United States has become progressively less effective. According to the FBI, about 40% of all known murder cases are not solved.

This is up from a rate of unsolved murders of 9% in 1963.

The reasons for the decline seem obvious. Protection of the “rights of criminals”, vigorously defended by organizations such as the ACLU and by liberal Supreme Court judges, has put victims of crime of all types at a disadvantage.

While the efficiency of law enforcement has declined, the fantasy of effective law enforcement has grown, encouraged by TV programs like “Miami CSI” that portray government law enforcement officials as incredibly efficient with an unbeatable arsenal of scientific crime-fighting tools.

In the case of investment fraud, the disconnect between reality and the fantasy of an all-protective SEC, puts millions of naive investors at risk. In a sense, it would be better to have no SEC at all and investors to realize that they were entirely on their own.

Bernard Madoff is in jail today because he turned himself in, confessed, and pleaded guilty, before his victims even knew they had lost their life savings.

One wonders what would have happened if he had taken the usual course. If he said nothing, waited for investors and the SEC to investigate, and then pleaded innocent, would he be in jail today?

The principle of non-merit regulation

One of the foundations of US securities market law enforcement is the principle of “non-merit regulation”.

What this means, in essence, is that the government should not be in the business of pre-judging investment proposals. The government’s job is to require “full-disclosure”, leaving it to the investor to decide what this disclosure means.

The problem here is two-fold:

1. What is meant by “full disclosure” is determined by government rules. In the case of Bernard Madoff — a mere investment advisor — the disclosure requirements were minimal, consisting of an obscure form filed once with the SEC and, although available on the SEC website, unlikely to have ever been seen by any of Madoff’s victims. Disclosure requirements always lag the invention of new ways of perpetrating fraud.
2. Most investors have neither the time, inclination, or skills needed to seek out and decipher SEC disclosure documents. In the case of Madoff, victims could have seen from the SEC website that Madoff was reportedly holding billions of client money in his own custody (not with a bank), managing these huge funds with the help of only a few people, and being audited by a tiny, one-man firm with an office in a strip mall in a New York suburb.

The SEC’s disclosure rule are dummied down by lobbying of industry groups, on the one hand, and by the larding of legal disclaimer boilerplate, on the other.

So here we have the problem of preventing future Madoffs in a nutshell:

• SEC staffers are not punished for failing to protect investors.
• SEC staffers may be punished for bothering a fraudster with political connections.
• The SEC policy is to leave investment decisions entirely up to the investors and not get involved.
• Law enforcement, in any event, is becoming progressively less efficient in the United States, where thousands, literally “get away with murder”.

Less, rather than more government, may be the solution.

The Crash of 2008 was the end to what I call, “the old capital markets”.

A new era is beginning, but form and detail are hidden in the mists of change. It may be a decade or so before new structures and directions are visible.

But before getting into the unpleasant chore of actually looking for a job, you should consider whether or not you even want to work in the new capital markets.

Warning: This is not a short article, but then, finding a new job is not always easy.

A different work environment

Historic events are unfolding in capital markets.

Hundreds of thousands will attempt to seek employment in a changing market. Some have been laid off as a consequence of institutional de-leveraging, bankruptcy, and the elimination of product lines.

Others, still employed, will be thrown onto the market soon enough, as the recession grinds on.

Students of finance and business, still in college, will soon be forced to consider whether to continue their current plans, marching forward to face stiff competition in smaller, perhaps less profitable financial fields, or whether it would be wise to re-direct their careers along a different path.

As the size of the market shrinks, due to de-leveraging and simplification of product lines, not everyone will find a job in “Post 2008 Wall Street”.

Hundreds of thousands unemployed in the financial sector

According to the Bureau of Economic Analysis, the number of people employed in the US finance and insurance industries peaked at 6.1 million in December 2006 and had fallen by 345,000 by January 2009.

However, many that are or will be unemployed by the contraction in the financial sector have no particular commitment to capital markets as a career path. There are many that work in human resources, building maintenance, clerical or secretarial positions, and similar “non-financial” jobs that can move to other sectors without discarding job skills or hard-earned professional credentials.

This article, however, is about those who have their educational background and job skills closely tied to financial markets and who would abandon professional qualifications by moving to a different sector of the economy.

It’s hard to say how many fall into this category, other than that it is far less than the number who will need to find new jobs as a result of contraction of the financial industry.

Financial markets may be shifting, but will not go away

Whatever the form the new capital market takes, people will continue to be gainfully employed in the field. Worldwide, the size of financial markets may even increase.

However, in certain cities, employment may be permanently reduced. College degrees that have currency in these markets will be accordingly devalued.

New York City, the traditional “Wall Street”, is an area that seems likely to be blighted for a long time. The net present value of Ivy League diplomas will suffer accordingly.

I, myself, have an Ivy League diploma that was useful decades ago in getting a first job on Wall Street. However, over the years, working in foreign markets, I found the credential to carry far less weight.

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